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Value Spreadsheet, officers, associates or clients may have an interest in the securities or derivatives of any entities from Value Spreadsheet referred herein. Our comments are an expression of opinion. When the market is in a bull or bear rally, it is harder to imagine a scenario or risk that can potentially impact the rally.
Similarly, when there is widespread optimism or pessimism, it is difficult to imagine a change in market characteristics in the short term as the fear at the bottom is intense, and visualizing events contrary to the crisis is stressful. However, the probability of making better returns increases significantly during the bottom. Global prices started to cool down, and the windfall tax was levied on export companies in these sectors.
Investing in these companies as prices correct may expose investors to losses indefinitely. Value can be found in not just low multiple but high multiple companies if the growth justifies and the price is below intrinsic value. The mispricing becomes more apparent when one is sceptical, as the herd is optimistic at the top and pessimistic at the bottom. In the bull swing, most portfolios are profitable, but as the market swings towards the bearish end, the herd takes flight to safety and waits for the dust to settle.
However, as the uncertainty resolves, no great opportunities will be available as the contrarian investor exploits the opportunity presented. This is the rationale behind why the contrarian style of investing performs better in a bear market. The contrarian style is not just doing things contrary to the market but also doing the same thing differently to yield better results. It teaches the second order of thinking: to look beyond the impact and not take things at face value, looking beyond what is apparent.
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Value investing is similar to contrarian investing, and at times the two have been compared to the point of showing no clear distinction. Again value investing relies on buying and owning shares of companies which are going down in the market.
Contrarian investing has a lot to do with behavioural finance. Behavioural finance is a field of finance involving input from other social sciences, such as psychology, sociology and political science. Psychologically speaking, going against the herd is rather a rarity, although contrarian investors are often very successful.
Fire Place. According to this theorem, many people lose a lot of money at the slot machines in the casinos. You know that you will lose much of the time but when you do win, your payoff will be dramatic. The Biggest Losers If you believe that investors tend to over react to events and information, the effects of that over reaction are most likely to be seen in extreme price movements, both up and down.
Thus, stocks that have gone down the most over a period are likely to be under valued and stocks that have gone up the most over a period are likely to be over valued. It follows, therefore, that if you sell short the former and buy the latter, you should be able to gain as the over reaction fades and stock prices revert back to more "normal" levels. In a study in , DeBondt and Thaler constructed a winner portfolio, composed of the 35 stocks which had gone up the most over the prior year, and a loser portfolio that included the 35 stocks which had gone down the most over the prior year, each year from to Looks good, right?
Timing is everything: Studies also seem to find loser portfolios created every December earn significantly higher returns than portfolios created every June. This suggests an interaction between this strategy and tax loss selling by investors. Since stocks that have gone down the most are likely to be sold towards the end of each tax year which ends in December for most individuals by investors, their prices may be pushed down by the tax loss selling.
Time horizon matters: In a test of how sensitive the results were to holding period, Jegadeesh and Titman tracked the difference between winner and loser portfolios by the number of months that you held the portfolios and their findings are summarized in the figure below. There are two interesting findings in this graph.
The first is that the winner portfolio actually outperforms the loser portfolio in the first 12 months. The second is that while loser stocks start gaining ground on winning stocks after 12 months, it took them 28 months in the time period to get ahead of them and the loser portfolio does not start outperforming the winner portfolio even with a month time horizon in the time period.
If you feel that, in spite of these caveats, this strategy may work for you, you can take a look at a list of the 50 companies that have gone down the most in percentage terms over the last 52 weeks June June I have added a stock price constraint to ensure that you don't end up with low-priced stocks and reported the dollar trading volume per day as a red flag for trading costs.
Your timing is off since it is not January but you can still browse for bargains. Collateral Damage It is not uncommon for markets to turn negative on an entire sector or market at the same time. In some cases, this is justified: a big news story that affects an entire sector, or a macro economic risk that hurts a market. As an example of the former, consider how banking stocks were punished on the day that JP Morgan Chase reported its big trading loss.
As an illustration of the latter, you can look at the Spanish stock market , where investors have punished all companies though some are less exposed to Spanish country risk than others over the last year. About a decade ago, I penned a paper on measuring company risk exposure to country risk that argued that we as investors were being sloppy in the way we assessed exposure to country risk, using the country of incorporation as the basis for measuring risk exposure.
With this view of the world, US and German companies are not exposed to emerging market risk, an absurd argument when applied to companies like Coca Cola and Siemens that derive a large chunk of their revenues from emerging or risky economies.
By the same token, all Brazilian companies are equally exposed to country risk, though some such as the aircraft manufacturer, Embraer derive most of their revenues from developed markets. This laziness in assessing country risk does provide opportunities for perceptive investors during crises. This was the case when Brazilian markets went into a tailspin in , faced with the feat that Lula, then the socialist candidate, leading in the polls, would win election to lead the country. As Embraer fell along with the rest of the Brazilian market, you could have bought it at a "bargain basement" price.
If you are interested in following this path, here is my suggestion. Start putting together a list of companies like Embraer, i. When there is one it is not a question of whether, but when It is trickier, though, playing this game within a sector. Consider the JP Morgan Chase case.
While the trading loss was clearly specific to JPM, you could argue that the event affected the values of all banks at two levels. The first is by increasing the chance that the Volcker rule, barring proprietary trading at banks, would be adopted, it affects future profitability at all banks.
The second is the fear that in response to the loss, the regulatory authorities would require higher capital ratios be maintained at all banks. If those are your concerns, you should focus on banks that do not make have a large proprietary trading presence and are well capitalized.
If investors have over reacted across the board, those banks should be trading at attractive prices. Comeback Bet When stock prices drop precipitously for an individual stock, there is usually a reason. If the drop reflects long term, intractable problems, there may be no reversal. If the drop reflects temporary or fixable problems, you are more likely to see prices reverse.
As you look at the reasons for the price drop, you should keep in mind your overriding objective, which is to find a company whose price has dropped disproportionately, relative to its value. Here are some possible reasons for a stock price collapse, with the ingredients for a comeback: a. Unmet expectations: When expectations are set too high or at unrealistic levels, it is inevitable that investors will be confronted with reality not matching up to expectations. When that happens, they will abandon the stock, causing stock prices to drop.
Netflix and Green Mountain Coffee, both of which make the list of biggest losers over the last year are good examples of what happens to high flyers when they disappoint Ingredients for a comeback: Expectations have dropped not just to realistic levels but below those levels. Investors have over adjusted. Corporate governance issues: Events that lay bare failures of managers and oversight by the board of directors shake investor faith and, by extension, stock prices.
Ingredients for a comeback: a A new CEO from outside the firm, b with a full cleaning out of management team and revamping of board of directors, and c an activist investor presence. Any suggestion of accounting fraud can lead to a meltdown in the stock price, not to mention open the company up to legal jeopardy. Ingredients for a comeback: a Full reporting of all accounting misstatements, with b removal of top management, and c no legal jeopardy.
Ingredients for a comeback: a Management that is not in denial about operating problems and b a realistic plan for dealing with operating problems. Financial problems: When operating problems combine with significant debt burdens, you have the seeds of distress, which can spiral very quickly out of control, as suppliers, employees and customers react pushing the company deeper into trouble.
Whatever the reason or reasons for a price collapse, investors have to follow up by asking and answering three questions: 1.
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